Friday, September 23, 2011

Higher US Wages Do Not Cause Loss Of Domestic Manufacturing

Lower wages in a foreign country are not the reason that manufacturing of a product declines in the US and increases in a foreign country and becomes an import.

Labor cost is about only 10-15 percent of manufacturing cost in the US. The US is a capital-intensive country. Each US worker, whether in farming or manufacturing, can produce a lot due to our heavy use of machinery. US worker productivity led to our high standard of living.

Capital and the complementary labor are allocated in the US to their most productive uses. These are the manufacturing and farming goods for which we have the highest international comparative advantages. The US exports these goods. It imports the remaining goods it wants after capital and labor are allocated to their most productive uses in the US.

Labor and capital in the US go to their most productive uses in a hierarchical fashion, until capital and labor are fully allocated. Goods for which it is not economically efficient to allocate capital and labor get imported.

The remaining manufactured goods, even if the US has an international comparative advantage (lower comparative wages, etc.), are not produced in the US, and are imported, because the US can more efficiently produce other goods for the world and domestic markets.

The market, labor and capital reallocations are the negative effects of this process. Government and union intervention can impose barriers to changes in resource use but it cannot stop it.

Certainly, since Ricardo's time, economists understood that a domestic economy benefits if it can allocate its resources to manufacture a good with a higher relative comparative advantage. Even if it is a low cost producer of goods it imports, as long as it has a bigger comparative advantage on the goods it manufactures, the domestic economy benefits from imports. See Wikipedia or any economics site on the web about comparative advantage and trade.

While unions are often blamed for high labor costs, it is their rigidity, their inefficient seniority linked demands, and other union rules, which causes the most problems. These union characteristics make other capital, labor investments more attractive, and impede the reallocation of union members.

Lower US labor costs for a doohickey do not guarantee a domestic US manufacturer, if there is a more productive use of those resources in the US. It can be beneficial to the US to import a good for which it is the low labor cost producer, if there is a better domestic use for that labor and capital.